SafeCo Insurance Company informs you that it costs $450 to acquire a new customer. Selling the exact same product to an existing customer only costs $150 (because a lot of the required data, such as a credit check, are already on file). Moreover, experience has shown that the probability of a customer dropping Safeco for another firm is 60% for 1-product customers; the probability drops to 40% with 2-products and to 10% with three products. The cost of maintaining a customer file is $200 per year and is independent of the number of products sold to that client.
Assume that each product generates $600 in contribution margin (i.e., premiums less expected payouts) per year.
Required:
Consider (1) a new customer buying one product, (2) a new customer buying 2 products, and (3) an existing customer adding a 2nd product. For each of these clients, calculate the expected profit earned for the next three years. How can you use the insight gained to justify offering price discounts to bundles of policies? (For simplicity, assume that a client will drop all or none of the products, and that the clients will not add new products in years 2 or 3.)